1. EXPLANATORY NOTES ON THE POLICY FRAMEWORK FOR THE IMPLEMENTATION OF A BUDGET
NORM SYSTEM AND A SYSTEM OF UNCONDITIONAL AND CONDITIONAL INTERGOVERMENTAL
TRANSFERS
The present document has been prepared to provide background information on The Policy
Framework for the Implementation of a Budget Norm System of Unconditional Intergovernmental
Transfers Paper. Because the Policy Framework is intended to become an official declaration of the
Ministry of Finance it was not the appropriate place for presenting rationales behind the systems’
design. We hope that the following remarks and comments will provide the necessary clarifications.
1. Legal background
The introduction of budget norm system is a requirement of the new Budget Law. Paragraph 11 of
Article 3 of the Budget Law defines budget norms as “recommended targets” for determining sector
and provincial budgetary allocations. Article 11 of the Prime Minister’s Implementation Decree
dated February 14th 2008 specifies that the Ministry of Finance is responsible for the implementation
of budget norms “for all concerned organizations from central to local levels.” Article 19 specifies
that norms include:
(1) Norms for the allocation of recurrent expenditures
(2) Budgetary norms for investment expenditures
Additionally, Article 20 stipulates that fiscal grants mentioned in article 43 and 44 of the Revised
Budget Law will be divided into two types:
(1) General grants
(2) Earmarked grants for (a) implementation of specific programmes or investment projects, (b)
emergencies resulting from natural disasters and other unforeseen issues.
2. PRSO-5
The successful implementation of a system of budget norms integrated with the Intergovernmental
Fund Transfer System has been recognized by the Ministry of Finance and by the World Bank as an
important success factor of the current public finance reforms. Adoption of the policy framework for
budget norms is one of PRSO-5 triggers. The deadline for meeting that condition is March 31st 2009.
3. Word Bank’s Aide Memoire
In order to assist with the implementation of the Revised Budget Law, a mission of the World Bank
has visited the Ministry of Finance between September 11th and 14th 2007 and results of the
discussions have been integrated in an Aide Memoire. The PRSO-5 trigger reflects implicitly the Aide
Memoire’s recommendations. Based on a common agreement, expenditure norms, unconditional
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2. grants and conditional transfers have been identified as the three major components of the Revenue
Sharing System.
The Aide Memoire defines a number of specific tasks to be undertaken for the system design which
have been integrated into the Budget Norm Work Plan finalized in November 2008. The key point
envisaged by the two documents is that the budget norm system and the system of unconditional
grants (the general grants of the Revised Budget Law) must be designed in parallel in order to reach
the highest level of integration with sectoral budget norms becoming the basis for the formula for
unconditional transfers (general grants).
4. Horizontal imbalance
Section I of the policy framework identifies the existing disparities in expenditure assignment as one
of the main issues of local budgets to be corrected by budget norms.
In fiscal year 2007/08, disparities in fund allocation between provinces resulted in variations of more
than 300% for the general budget, and 200% for the recurrent budget on a per capita basis.
Disparities on such a scale represent a very significant challenge and the adjustment process needs
to be gradual. Constraints are not only the limited resources of the central Government but also the
absorption capacity of the provinces; most of them would not be able to use efficiently sectoral
budget increase of more than 10% above national average in one year. An equalization model and a
financial strategy have been developed showing that a transition period of six years is required.
5. Fiscal Sustainability
A macro-fiscal model has been developed to ensure that the impact of equalization on the general
budget remains sustainable. Results generated by the model show that adjustments (recurrent
budget and investments) will represent on average a yearly amount less that 1% of the general
budget over a period of six years. The required adjustments will be 0.4% on the first year, 0,8% on
the second year and 1,3% on the third year before declining again the next three years. Such a low
cost could be easily absorbed by inflation and there will be no need for the Ministry of Finance to
earmark additional resources for the implementation of budget norms.
6. Existing constrains
The legacy of the central planning system put important constrains on the design of the budget norm
system and the system of intergovernmental transfers. Accommodating these constrains make the
system more complex that those existing in other countries, including Vietnam. The three most
important constrains are dual budgeting, revenue assignments based on three flows of revenues
(local revenue, central revenue and shared revenue) and the management of ceilings on staff
recruitment.
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3. 7. Link between planning and budgeting
International experience of the last twenty years shows that the most critical success factor in
economic development is a strong link between planning and budgeting. In Lao PDR, that link
remains weak and will need additional strengthening. The introduction of budget norms will require
a stronger cooperation between the Ministry of Finance and the Ministry of Planning and Investment
(MPI). This cooperation will need to be institutionalized to cover not only budget norms, but also
macro-fiscal planning and multi-year budgeting.
One of the main consequences of dual budgeting is a high priority given to investments without
sufficient funding for the long term maintenance of infrastructure and for other operating costs.
Whereas as by international standards education operating costs should represent a minimum of
20% of the sectoral budget, on average operating costs for education in Laos PDR represent only 3%
of local budget. To compensate for this low recurrent budget, many provinces have used the
investment budget for maintenance operations, blurring the distinction between recurrent budget
and investment budget.
The introduction of budget norms for investment will require a better definition of how expenditures
can qualify as investment. Almost all countries define investment as fixed assets with a minimum
spending by line-item (usually around US$ 5,000) and a life expectancy of five years. It might be also
useful to distinguish between small investments such as photocopy machines or vehicles, which can
be left to the discretion of the provinces as part of the recurrent budget, and large investments
requiring approval of the Ministry of Planning.
8. Expenditure need transfers
The need to base the intergovernmental transfers on expenditure needs and not on revenue
assignments is the consensus reflected in the World Bank’s Aide Memoire. Considering the existing
disparities in local revenue collection between provinces and the difference in poverty level and
economic development, a system based on revenue assignments would only result in exacerbating
horizontal imbalance.
However the system of transfers based on general (unconditional) grants has to be made compatible
with the system of shared revenue already in place. Because the size of the shared revenue transfer
will not affect the size of the general grants, the system must ensure that advantages given to
provinces on the basis of land area and poverty level in the shared revenue formula are integrated
in the budget norm system.
Sectoral formula will include coefficients taking into account poverty level and other local variables.
Adjustment in the budget norm structure will be made to ensure that equity in inputs per capita does
not lead to inequity in outputs; for example cost of road maintenance can be much smaller in plain
areas compared to mountainous areas. Low density population in some area generates additional
costs for the delivery of the same service. In general, the system will ensure a maximum level of
flexibility and sensitivity to real local conditions.
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4. 9. Should budget norm include salaries?
The Policy Framework distinguishes between two types of norms: (a) sector budget norms, which
are in fact expenditure norms, applying to the calculation of the general grant, and (b) and economic
norms applying to allocation of the budget by economic categories.
Sector budget norms will define a targeted level of spending applying to most provinces with a few
exceptions. This level of spending could stipulate that the target for education spending will be
110.000 kip per capita or 50.000 kip per student for example. This amount, used in the grant transfer
formula, will include salaries but will have no direct affect on the level of salaries, on the number of
staff or on the staffing structure. On the other hand, salaries will not be included in the budget
norms by economic categories.
In practice, budget norms will leave unaffected the portion of the budget allocated to salaries.
10. Investments
The Budget Law and its Implementation Decree stipulate clearly that budget norms should apply
both to the recurrent budget and to the investment budget. The Implementation Decree gives the
overall responsibility for the system implementation to the Ministry of Finance without clarifying the
respective responsibilities of the Ministry of Finance and the Ministry of Planning and Investment in
the system design and the periodic revision of norms.
We suggest the following principles as a basis for consultation with the Ministry of Planning:
 The Ministry of Finance will be responsible for communicating to the Ministry of Planning the
overall fiscal envelope available for investment
 The Intergovernmental Transfer System will have separate unconditional grants for recurrent
expenditure and for investments
 The Ministry of Planning and Investment will be responsible for defining budget norms for
investments
 Only a portion of the investment budget will be regulated by budget norms
 A distinction between small and large investments will be introduced, with small investment
becoming part of a general grant and large investment being financed by earmarked grants.
 Very large investments such as major infrastructure projects will be financed by earmarked
grants
However, a number of issues remain:
 How to allocate the investment envelope by sector?
 Who will allocate the sectoral investment budget by provinces?
 How to define investments left to the discretion of the provinces?
 How to integrate the impact of investments on the recurrent budget?
 How to coordinate investment and recurrent expenditures at the provincial level?
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5. 11. Need for local planning
In each sector, a number of provinces are well below the national average level of spending on a per
capita basis. Clearly it means that these provinces are unable to provide the same level of
Government’s services as more advanced provinces. The equalization effect of budget norms should
provide to those provinces additional resources that will allow them to improve their level of
services. However this equalization process should be undertaken gradually and implies considering
issues which are beyond the scope of budgeting. Improving service delivery will require a strong
planning process and, probably, additional investments. The absorption capacity of the less
developed provinces might be the most important bottleneck for the implementation of budget
norms.
Whereas more funding for “goods and services” can generate a rapid improvements in service
delivery, the equalization model shows that other actions are required. The less advanced provinces
have suffered from underinvestment that has created a situation that only can be corrected over a
period of several years. Disbursement of that portion of the general should be made conditional on
the production of such a development plan and its approval by all relevant authorities.
The preparation of these development plans could be included in the revision of local budget
structure and process which is already part of PFMSP work plan.
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